After The Post-Earnings Pop, Upside for Yum China Stock Looks Limited


What slowdown? While everyone and their best friend has been worried about a massive slowdown in China economic activity, Yum China (NYSE:YUMC) reported robust fourth-quarter numbers last week that didn’t show any signs of a slowdown. Comparable sales growth across the whole system improved. KFC comps came in at their best level since Q1. Pizza Hut comps were the best they’ve been all year . Margins improved. The outlook was healthy. The conference call was bullish.

Overall, it was a really good quarter from Yum China, which dispelled the “China is falling apart” bear thesis. YUMC stock is  up 15% since the report.

Compare this directly to Yum! Brands (NYSE:YUM), which this morning reported a year-over-year earnings decline and a revenue miss. So far in this morning’s trading, YUM is down about 5%.

While there’s reason to be bullish on an economic turnaround in China and on Yum China’s numbers remaining impressive over the next several quarters, further upside in YUMC stock seems limited for the foreseeable future. The valuation is full-up, and investors are seemingly already pricing in healthy and stabilized growth for a lot longer.

As such, unless Yum China’s comparable sales trajectory improves meaningfully over the next few quarters (which seems unlikely), then YUMC stock will likely trade sideways over the next few months. That means this rally is a good opportunity to take profits.

What Slowdown?

We’ve all heard the news. We’ve all seen the numbers. China’s economy is rapidly slowing. GDP growth is running at a thirty-year low, while retail sales growth is running at a fifteen year low and consumer and business confidence are slipping.

But, you wouldn’t guess any of that by just looking at Yum China’s Q4 numbers.

Nothing about Yum China’s Q4 earnings report indicates that China’s consumer economy is slowing. Total comparable sales growth was 2%, better than the full-year 2018 mark and the best mark since the first quarter. KFC’s comps were up 3%, also the strongest reading since the first quarter. Meanwhile, losses at Pizza Hut narrowed, with comps coming in at down 4%, better than the third quarter’s 5% drop.

Because unit economic trends didn’t deteriorate, Yum China kept opening stores. In 2018, the company opened 819 stores, or more than two new stores a day. Thus, this company remains well on track to grow its store base to 20,000 over the next several years (the store base currently stands at under 8,500).

Also, margin trends improved during the quarter. Margin compression has been a major headwind all year long. That wasn’t the case in the fourth quarter. Despite sizable wage and commodity inflation, company-wide margins were actually stable year-over-year. Thus, once inflation backs off, margins will have runway to move higher.

Overall, the quarter was very good. Growth trends are actually improving, as are margin trends, at a time when they are supposed to be deteriorating. That speaks to the strength of the underlying Yum China growth narrative, and the staying power and resilient popularity of KFC and Pizza Hut in China.

Yum China Stock Is Fully Valued

Strong Q4 numbers confirm the health of Yum China’s underlying growth drivers.

Namely, China remains a double-digit consumption growth economy thanks to urbanization and digitization tailwinds, while the dining market remains a high single-digit growth sector of that red-hot economy, powered by deeper digital penetration and robust unit growth. (Restaurants per capita in China remain well below the developed country norm.)

Yum China is at the heart of that growth narrative. As such, this company will benefit from mid single-digit unit growth over the next several years, and flat to low single-digit comparable sales growth. That combination should lead to mid to high single-digit revenue growth. A mid to high single-digit revenue growth rate, coupled with cooling inflation trends, should help push margins slightly higher over the next five years.

Modeling those assumptions out, $2.60 seems like a reasonable EPS target for Yum China by fiscal 2024. Big restaurant stocks normally trade around 20x forward earnings. Based on that average forward multiple, a reasonable fiscal 2023 price target for YUMC stock is $52. Discounted back by 9% per year (1% below my normal 10% discount rate to account for the 1% yield), that equates to a fiscal 2019 price target in the mid-to-upper $30’s.

Thus, at the current YUMC stock price of $41.50, the stock seems fully valued, if not a little expensive.

Bottom Line on YUMC Stock

Yum China’s Q4 numbers were really good, and underscore that this company’s long term growth narrative remains vigorous. But, the valuation on YUMC stock seems full after this recent pop. Further upside seems limited. The most likely outcome over the next few months for YUMC stock is sideways trading.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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